IN GENERAL

The previous chapter discussed the taxation of passive income. This chapter will discuss the taxation of active or business income, that is, income whose source is under the taxpayer's control. The first thing to realize is that a significant change was made to attract foreign investors in the mid-1960s, when again, because of the Vietnam War, the United States needed a great deal of foreign capital. This change was as follows. Before 1966, the basic dichotomy was that foreign investors, nonresidents, were taxed on passive income (FDAP) at 30 percent on the gross, subject to all of the exceptions, whereas active income was taxed on a net basis with progressive rates. This continued after 1966, but the test for which rule applied changed.

What is the test as to whether you are under the active income umbrella? The test is whether you have a “trade or business” in the United States. That is the language of Code 871(b). We will discuss later what exactly that means, to have a U.S. trade or business. But the interesting question is, suppose you have one (and it is as we will see very easy to have one, a very minimal level of activity would qualify you) – which income then becomes subject to the active side?

Until 1966, the United States had what is called a “force of attraction” rule, which is the rule that the UN model treaty and most developing countries prefer.